Why Keep Emotions at Bay When Investing in Mutual Funds

October 25, 2021 Mutual Fund

In the past one and a half years or so, equity mutual fund investors have been through a roller coaster of emotions. As the equity market moved from multi-year lows in March 2020, to all-time high in the recent months, investor emotions too have sailed from extreme fear to euphoria.

Equity market and emotions often go hand in hand. However, reacting every time market fluctuates can make it difficult for you to focus on your financial goals. For instance, during market downturns it can be dreadful to see the value of your hard-earned money eroding. In such a case, if you decide to redeem your investment you will convert your notional loss into actual loss. This will prevent you from giving your investments an opportunity to grow over a period.

What you need to remember is that ups and downs are unavoidable when it comes to investment in equity mutual fund.

Here is how you can avoid emotional investing:

1) Do your own research

Emotions can often come in the way of your investments when you don’t know how to react in a particular situation. Therefore, you must do your own research before investing. You must avoid investing in a product offering that you do not fully understand. In the words of Peter Lynch “Know what you own, and know why you own it.”

Carefully read the product-related documents to have a better understanding about its characteristics, potential benefits, risks involved, etc. and make an informed decision. If you feel unconfident about financial planning and in making the right investments, then it would be better to seek professional help.

2) Avoid herd mentality

Often you may be tempted to follow the investment strategy/style of well-known investor, particularly when you see them tasting success. However, their investment strategy may not align with your own risk profile or financial goals. It may also happen that by the time you try and invest by imitating their strategy, it may be too late.

Furthermore, never invest in any scheme due to hype, hearsay or tips from friends and relatives. You should allocate your investment in equity mutual funds after evaluating your needs. This will make your journey to wealth creation less risky. Click here to find out which mutual fund category is suitable for your goals and risk profile.

3) Invest via SIP with along term view

A common mistake that investors make is to treat equity mutual funds like stocks. Even though equity mutual funds are market-linked and returns are not guaranteed, it must not be a cause of worry if you have a long term investment horizon. The impact of volatility on your mutual fund returns negates over a period of time and you get the opportunity to earn handsome returns in the long run. Therefore, you must avoid investing in equity mutual funds if you have a short term investment horizon of less than 3 to 5 years.

Investing via mutual funds via SIP makes timing the market irrelevant, so you do not have to worry about market conditions. You buy less units via SIP when the market is on an upward trend and buy more units when there is a market downturn which averages out the cost of investment.

4) Diversify to ensure peace of mind

A well-diversified portfolio of mutual funds helps to lower the risk and ensures peace of mind. It is a well-known fact that no two mutual fund categories generate similar returns at any given point of time. By diversifying your investment across various categories and sub categories, your portfolio will be well placed to cushion the effects of market volatility and grow more efficiently when the markets are high.

Allocate assets across schemes/categories as per your based on your goals, risk profile, and investment horizon. This will save you the hassle of constantly churning your portfolio in line with the dynamic market conditions.

5) Monitor your investment

Equity mutual fund investments are susceptible to market ups and downs. Checking the performance of your schemes on a daily basis can induce stress and anxiety. But as mentioned earlier you need not worry about it when you are investing with a long term view.

However, you still need to monitor the progress of your portfolio regularly such as half yearly or yearly. Doing so will assure you whether your portfolio is on the right track to achieve your goals. It will also help you find out if there is a need to make changes in your portfolio like replacing a fund that has consistently underperformed or to rebalance asset allocation.

To conclude

Reacting to market behaviour can lead to unnecessary stress and cause you to deviate from your goals. Equity market movement is dynamic in nature; no one can predict where the market may be heading next. So instead of reacting to market movement, one must focus on their goals by building a suitable portfolio that can stay strong on both upside and downside market conditions.

You can consider opting for the Core & Satellite approach to investing, a mutual fund investment strategy that will help you to shut the market noise and will also help to focus on your goal. The ‘Core & Satellite’ is one such investment approach that will help you to become a successful investor. It is a time-tested investment strategy followed by some of the most successful equity investors in the world.

The ‘Core & Satellite’ strategy would ensure risks and returns are well balanced out. The term ‘Core’ applies to the more stable, long-term holdings of the portfolio, while the term ‘Satellite’ applies to the strategic portion that would help push up the overall returns of the portfolio, across market conditions.

The ‘Core’ holding should comprise around 65-70% of your equity mutual fund portfolio and consist of a Large-cap Fund, Flexi-cap Fund, and Value Fund/Contra Fund.

The ‘Satellite’ holdings of the portfolio can be around 30-35% comprising of a Mid-cap Fund and an Aggressive Hybrid Fund.

By wisely selecting among these, the best mutual fund schemes, structuring your portfolio, and then timely reviewing the Core and Satellite portions and the holdings therein, you would be able to strategically boost your portfolio returns hand-in-hand with the required stability.

This article first appeared on PersonalFN here